Foreign Direct Investment is a term which has been used repeatedly on this blog. But what exactly does it mean & what are its implications & effects? Here's what.
Simply put, Foreign Direct Investment is the money invested by a foreign enterprise into a domestic enterprise to gain a controlling stake which according to Organization of Economic Cooperation and Development (OECD) defines control as owning 10% or more of the business. A 10% ownership doesn't give the investor a controlling interest. It does allow influence over the company's management, operations, and policies.Some recent examples of FDI are:
Facebook, Inc. announced an investment of Rs 43,574 crore (US$ 6.23 billion) into Jio Platforms for 9.99 per cent stake.
French oil and gas giant, Total S.A., acquired 37.4 per cent stake in Adani Gas Ltd for Rs 5,662 crore (US$ 810 million), making it the largest FDI in India’s city gas distribution (CGD) sector.
FDI RANKINGS
TYPES OF FDI
HORIZONTAL FDI: Under this type of FDI, a business expands its inland operations to another country. The business undertakes the same activities but in a foreign country. EXAMPLE: Tata Consultancy Services acquires American Insurance Ltd to expand to the American market.
VERTICAL FDI: In this case, a business expands into another country by moving to a different level of the supply chain. Thus business undertakes different activities overseas but these activities are related to the main business. EXAMPLE: Burger King acquires Pele Coffee of Brazil to strengthen its coffee supply chain worldwide.
3.CONGLOMERATE FDI: Under the type of FDI, a business undertakes unrelated business activities in a foreign country. This type is uncommon as in involves the difficulty of penetrating a new country and an entirely new market. EXAMPLE; Berkshire Hathway (owned by Buffet) invests in Unibox Furnishings of California. To know more about Conglomerates, CLICK HERE (really good article)
4.PLATFORM FDI: Here, a business expands into another country but the output from the business is then exported to a third country. EXAMPLE: Nike Inc enters into a Joint Venture with Hanoi Shoes of Vietnam to gain access to its factories and export shoes to the Pacific region.
NOTE: THE ABOVE EXAMPLES ARE FICTITIOUS FOR BETTER UNDERSTANDING
METHODS OF FDI
Mergers and Acquisitions
Getting voting stocks in a business based in another country
Joint ventures with firms based overseas
Starting a subsidiary of a domestic firm in a foreign country
PROS OF FDI
It bolsters foreign exchange reserves of the recipient country.
If FDI is in form of merger or joint venture, the domestic company can gain access to advanced tech of foreign company
FDI in developing spheres of economy can lead to job creation & employment.
A foreign company can penetrate more easily by using brand name and supply chain of a local company. EXAMPLE: Lenovo acquires Dell in USA.
It promotes innovation as resources of 2 companies are used to tackle market challenges.
FDI also increases exports if FDI is platform type.
CONS OF FDI
There is a loss of profit to the domestic economy as when a foreign company acquires a domestic enterprise, the profits are routed to the foreign economy. EXAMPLE: If Parle, a famous Indian brand is acquired by Britannica then its profits would go to its parent company in UK.
FDI in strategically important sector like Defense Equipment Manufacturing can be harmful for national interests.
In all the countries where the FDls have made an inroad, there has been a cultural shock experienced by the local people, adopting a different culture alien to the country. The domestic culture either disappears or suffers a setback.
In order to capture the foreign market, the FDIs have gone to the extent of even corrupting the high officials or the political bosses in various countries. Lockheed scandal of Japan is an example
CONCLUSION
So is FDI good or bad? I can say its both. It depends on how th government manages it. The governments need to vigorously monitor FDIs to see whether they harm national interests or not. For example, China took advantage of the poor economic condition in India & invested heavily in Indians companies at discount rates. The Indian Government responded by reversing this inflow of capital & adding China to a watchlist. Such quick actions are always good for the economy.
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